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Goldman Sachs' top 10 themes for 2013
on Dec 04, 2012 at 07:00
A stronger year for emerging markets, more unconventional monetary policy and a continued revival in the US housing market are among the themes the investment bank expects to dominate next year.
Moving over the hump
An eight-strong global team of Goldman Sachs global strategists have put their heads together to come up with 10 themes which will dominate markets over the next 12 months.
In a detailed note, titled 'Moving over the hump', the teams finds reasons to be both positive and negative in 2013.Today’s Global Economics Weekly “Moving over the hump” describes the main elementsof our economic forecasts for 2013 and beyond. This year, we plan to release our TopTrades for 2013 beginning in Monday’s Global Markets Daily. Here, we lay out our Top TenMarket Themes, which represent a broad list of macro themes from our economic outlookthat we think will dominate markets in 2013. For each theme, we discuss the widerimplications for markets, and the potential issues and options for investing around them.
Global growth: a ‘hump’ to get over
On the surface, our global growth outlook for 2013 looks like more of the same: US GDP growth at around 2%; a near-recession in the Euro area; Chinese growth below the average of the last 5-10 years; and below-trend global growth once again – at 3.3%. But there are significant differences below the surface: further healing in the US housing and labour markets; a progressive relaxation of the global energy supply constraint; and ‘room to grow’, particularly in the developed world.
The biggest challenge from a markets perspective is that we see risks to growth concentrated early in the year, with Q1 likely to show a step-down in growth globally. Fiscal restraint plays a major role in that story: we expect a big increase early in 2013, but a significant fading on both sides of the Atlantic thereafter. ‘Fiscal cliff’ resolution still presents a particularly acute version of that uncertainty. But if that period can be navigated, we envisage a sustained sequential recovery in growth, which builds into 2014 and beyond. This profile means that beyond the next quarter or two, markets may face a steadily improving picture, with a broadening US private-sector recovery.What does this mean for equities?
If markets recognise this, 2013 could prove to be another solid year for global equities. But the key challenge will be how quickly the market can look beyond near-term macro weakness. In thinking about the extent of the near-term downside, an important question is what growth outcomes are already priced. On our estimates, equity markets are priced for close to 2% GDP growth in the US, and global growth that is further below trend. At thoselevels, even a period of modestly slower growth may not be too disruptive. But the market has already recognised the relative resilience of the US and may be vulnerable to near-term news that undermines that view.
The same timing challenges apply to the cyclical tilt within equity markets. Sharp underperformance of global cyclicals relative to defensives has been a feature of both 2011 and 2012, and we expect this to begin to reverse in 2013. But our forecasts do not imply global growth that is clearly above-trend until 2014, so the risk is that this shift also builds only slowly through the year.
More unconventional easing in the G4
2013 is likely to see more unconventional easing from the major central banks. Our view of the Fed easing profile remains more aggressive than market pricing and we expect a shift towards macro-based rather than calendar-based forward guidance.
In the Euro area, beyond the activation of the OMT (outright monetary transactions), our forecast that the ECB may shift to targeted private asset purchases is one that may bolster the appeal of Euro corporate andbank credit at some point. But the shift is likely to come in response to a continued freeze in private-sector credit availability in the periphery, especially Spain.
However, the most hotly debated shift currently is whether the Bank of Japan (BoJ) will make a more convincing attempt at easing. We have been sceptical through this year about the potential for yen weakness on the back of expectations of a larger BoJ move. And while we do expect incremental progress, our central case is not for a quantum leap in BoJ policy, particularly in the near term. But more aggressive comments about 2%-3% inflation targets from the leader of the LDP, Shinzo Abe, and the chance to appoint a new BoJ governor in April make it easier to see changes taking place. The danger of positioning for a weaker yen is that a convincing shift may require the BoJ to ‘out-ease’ a committed Fed, which we do not expect.
But other assets – the long-underperforming equity market, including banks – could benefit from any increase in absolute (rather than relative) easing commitments. They may be a better ‘call option’ on a potential policy change, particularly in a supportive global equity environment, though they have already done well in recent weeks.
Termites eat away at the foundations of the ‘search for yield’
A sluggish post-bust recovery, significant private-sector surpluses and the impact of QE on term premium have kept ‘safe’ sovereign yields very low, particularly through an unusually depressed real rate structure. We have shown how, in turn, that has fuelled appetite for carry and for ‘safe’ risk in general, and led to unusual strength in defensive equities in the US and Europe.
In the first half of 2013, there is little in our forecasts to suggest that the basic environment is set to shift, given sub-trend US growth, large ongoing asset purchases and sluggish global GDP growth. Even looking further out to the end of 2013, we expect QE3 to be in full swing and the overall growth environment to improve only gradually. We show an upward drift in our 10-year bond yield forecasts, and our profile for US 10-year yields is above the forwards. But our best guess is that the pace is not enough to deter the search for carry and yield in many places. Even though we expect the search for yield to continue, the risk-reward is falling. Particularly as we move later into the year, it is easier to think of forces that could push longer-dated real rates more decisively higher.
For places where the premium offered is either low in absolute terms (agencies) or relative to the liquidity risk involved (parts of EM credit), we think the risks – while most likely to be avoided in 2013 – are growing, so carryopportunities need to be more substantial to justify taking them. Gold – also supported by ultra-low real rates – is becoming more vulnerable to these same forces.
In between those alternatives, corporate credits – which have good fundamentals and a better liquidity profile – should continue to see a slow and modest tightening in spreads. But even here, the risks are greater than in the past couple of years. And we expect tight spreads on plain vanilla instruments to increase demand for structured products.
The mirror image of stronger growth and slower private-sector deleveraging towards the end of 2013 and into 2014 is an increase in corporate investment and activity, and a gradual deterioration in balance sheet fundamentals. For 2013 this is probably still only a risk to watch: excluding peripheral Europe, corporate credit quality (as measured by debt-to-earnings measures) remains good in most markets, and this should continue to support the fundamental risk profile of most credit portfolios.
Housing stabilisation and private-sector healing in the US
The positive surprise from the US housing sector has been one of the big stories of 2012. US homebuilding stocks have doubled and US domestic cyclical stocks have substantially outperformed US global cyclical stocks. While we see continued healing in the household sector and ongoing gains in both housing starts (20% growth in 2013) and home prices (2%-3% growth in 2013), this may now already be priced in by markets. Simple macro comparisons with our Wavefront Housing Basket suggest that pricing of equities most directly related to housing construction (homebuilders, durables) are broadly consistent with the improvement in the data itself.
Further progress in housing indicators could still support these areas. But given the strong re-pricing of assets related to homebuilding, it makes sense to think more about the ripple effects of housing stabilisation beyond these areas.
On that front, two kinds of assets come to mind. The first is select vintages of the ABX index on subprime mortgages. The higher rated tranches have already re-priced significantly, but still price in severe future mortgage default assumptions that are more likely than not to surprise on the low side. They are clearly sensitive to further home price strength and may also provide a ‘call option’ on shifts in housing policy to help underwater borrowers.
The second is US domestic banks, which could benefit further from a gradual normalisation of housing credit finance if home prices continue to drift higher. Specifically, given the prevalence of sustained low mortgage rates and wide refinancing spreads, banks should benefit from increases in refinancing volumes. Since the crisis, mortgage exposures are embedded within larger financial institutions, which means that investors take on other risks here alongside exposure to improving housing markets.
Euro area a smaller driver of global risk, but still a source of tails
This time last year, Europe played a decisive role in our views of the global risk environment, and the shifts in European risk have been a key driver of both weakness and more recent strength in global asset markets in 2012.
In 2013, despite ongoing growth weakness in the Euro area, our central case sees less of a role for European issues to drive the global risk picture. This is partly because policy measures and institutional innovations reduce the deep systemic risks that have been the most likely source of global transmission; but it is also because we expect a continued ‘muddling through’ by Euro area policymakers that mitigates spikes in local risk. The best opportunities to take directional exposure to Europe have come either when the market believes that the system is close to collapse (as it did again in May) or when there is confidence that the key risks have been resolved. Neither is true right now.
With risk premia still wider than elsewhere, and larger than warranted by fundamentals alone, further policy progress – and an absence of fresh stresses – could see incremental gains in Euro area assets. Even so, investors will need to be prepared to navigate well flagged downside risks: Spanish economic pressure that could escalate into political risks unless the ECB intervenes to ease financial conditions; and Italian political uncertainty ahead of the March general elections, which could lead to fresh concerns about a slowdown (or reversal) in the pace of reforms in one of the larger EMU members.
While low-probability events, we still see these as a key source of risk to global assets, and see areas where the market has now relaxed significantly – the €/$ skew and the €/$ cross-currency basis – as potential hedges. Away from these areas, debt restructuring issues, the treatment of legacy debt in Greece and beyond, Ireland or Portugal potentially regaining market access, and the move towards banking union could provide investment opportunities in 2013.
Continued divergence between core and periphery in the Euro area
The divergence in growth between the Euro area core (Germany in particular) and the periphery (Spain in particular) is set to continue. Periphery weakness is already well-known, but the potential for German overheating is a more distinctive theme. Non-traded domestic construction and services areas of the German economy are likely to continue to outperform, while traded/manufacturing sectors in the periphery should also outperform, as part of the process of real exchange rate realignment. The challenge is finding suitable market implementations. German housing and services sectors are obvious beneficiaries but equity exposure in those areas is limited.
The relative profiles priced into inflation markets in Germany and Italy could offer another (more limited) possibility. Beyond that, the scope for this kind of exposure becomes more indirect. Of these, the CE-3 is most intriguing; Poland is the most tightly linked to the German economy and we expect less easing here than the market. This suggests that a stronger German recovery could perhaps reinforce the case for the PLN relative to others in the region, at the price of introducing other idiosyncratic risks.
EM growth pick-up revisits capacity constraints
Growth in the EM world is likely to accelerate significantly between 2012 and 2013, and we have seen some nascent signs of this in the past couple of months. But the market environment here is more complicated than in the DM world, primarily because output gaps are generally not that large in absolute terms, and are certainly more limited than for DMs.
In addition, the cyclical upturn in growth in some of the larger EMs (such as China and Korea) needs to be set against the fact that trend growth rates may slow modestly over the long term. Lastly, we forecast a moderate sequential slowing in China in 2013 Q1 before limited acceleration for the rest of the 2013 and 2014.
In light of these nuances, the key market issue is how strongly to position for a rebound in EM equities, which have underperformed for much of the last couple of years. We think EM equities should have a better year, but the upside potential may be limited by the fact that inflationary pressure and a potential shift towards tightening could come earlier than the market expects in places.
This tightening dynamic – largely absent in the DM world – and lingering concerns about imbalances (domestic ones related to housing or the pace of credit growth in China or Brazil, and external ones linked to current account deficits in India and Turkey) leave us thinking that even if EM equities outperform DM in an absolute sense, the outperformance is unlikely to be enough given the higher risk or variance in outcomes.
EM differentiation continues
While we expect the EM universe as a whole to see better growth and somewhat more inflationary pressure, the differences across EM are at least as striking as their similarities. We think some places will deliberately aim for weaker FX (Czech Republic), while others are in tightening mode already (Russia).
Current account imbalances are still a significant risk for Turkey, India and (most dramatically given a fixed exchange rate) Ukraine. The ‘orthodoxy’ of the central bank reaction function to inflation is also likely to vary, and so the risk in some places is that even with building inflationary pressure, policy does not necessarily tighten (Turkey and perhaps Brazil face that risk) or tightens in ways that are not easily reflected in market pricing.
Valuation also varies significantly, with some currencies (parts of Asia, the MXN and more recently the ZAR) looking substantially undervalued on a longer-term view, while others look more ‘rich’. The shift to tightening may also be a source of EM opportunities in the year ahead. The market may be underestimating the scope for rate hikes (in some ASEAN markets, such as Indonesia or Malaysia) or overestimating the scope for easing in places (Poland), especially if global yields drift higher as well. It is also possible to envisage policymakers in places that have resisted appreciation lately (Brazil, South East Asia, Korea) tolerating some currency strength as inflation pressures build later in 2013 and in 2014.
Commodity constraint to loosen in the medium term
The basic structure of our commodity price views has changed substantially in recent months as the implication of US shale production becomes clearer. Having seen markets that were heavily supply-constrained, we are now seeing the supply responses begin to take effect. Most importantly, we expect oil markets to return to a more structurally stable position, where the ability to bring on new supply in the $80-90/bbl range is rapidly increasing.
The relaxation of the energy supply constraint globally reduces one major obstacle to a global recovery as we look to above-trend global growth into 2014 and beyond. Our bias to express cyclical views through directional energy exposures is also lower as a result. But this takes us back to markets that have a structure which (at higher longer-dated prices) is more like the pre-2003 operating environment.
With markets likely to remain cyclically tight but structurally stable, commodity curves in oil, soy and potentially copper are likely to remain ‘backwardated’. So the carry from owning commodity indices (which buy the front end of commodity curves and roll up to spot levels) may be stably higher again. We also think that the pipeline constraints that have kept WTI and Brent at wide spreads for some time are likely to be resolved in 2013, although positioning for that outcome involves significant negative carry, so timing is important.
Stable China growth, but not like the old days
Although we expect Chinese growth to stabilise next year, the pace of growth we envisage is still only a touch above 8%. So the question of how far the market has already adjusted to the slowing in China’s growth profile will remain important.
In some areas, stabilisation may be enough to provide some further relief. Our China ‘risk factor’ analysis suggested that some key assets – Chinese equities and the CNY forward points, in particular – had reflected large downgrades to China growth views. And while there has been a meaningful rebound in the market’s pricing of China risk in the last three months, there may still be scope for stability alone to provide relief.
Elsewhere, it is less clear that persistently slower Chinese growth has been fully reflected. Our Commodity Research team’s analysis of the Chinese construction cycle suggests that iron ore demand is likely to remain soft as core building demand falls, and that copper will receive a boost from the completion of new buildings in the next 6-9 months, but is likely to peak thereafter.
Tim Toohey and team also continue to highlight the peak in Australia’s resource investment boom and the risks that continued declines in the terms of trade could pose there. Those dynamics have begun to be appreciated by policymakers and may not have a big impact on the 2013 Australian growth picture. But we expect slower growth and lower rates to be more obvious in 2014.
The broader question is whether the market begins to worry about the AUD or other currencies most levered to Chinese growth, or to differentiate more aggressively within the commodity FX universe ahead of that point. These assets may offer independent opportunities or a means of hedging a broader procyclical view in equities.